India boasts of a young population with a composition of maximum middle-class individuals who keep aspiring for growth at all levels. However, to accomplish any form of growth, access to timely funding is of the essence.
More and more individuals are now turning towards loans for investment in avenues such as education, homes, etc to enjoy a better future. This fast-paced demand for various kind of loans in India has caught lenders attention and most banks and NBFCs in India are beginning to offer a huge variety of loans to meet the requirements of such aspirational individuals.
When it comes to qualifying for loans, not everyone is offered loans easily by Indian banks or NBFCs. Especially in the case of self-employed individuals, the income could be seasonal or heavily influenced by market factors, hence acquiring loans can be difficult. Also, most banks and NBFCs place significant emphasis on credit scores while performing due diligence of a loan application.
Those having a low credit score or no credit history and those who cannot be placed within a standardised category find it difficult to get a loan. This is where peer to peer lending comes into the picture. In this blog, we will explain everything you need to know about peer-to-peer lending and borrowing.
What is Peer to Peer Lending?
Peer to Peer lending, frequently referred to as P2P lending, allows individuals to easily lend/borrow money from other individuals without the necessity to depend on regular banking channels. P2P lending can also be called a kind of crowdfunding that helps to match borrower’s and lender’s needs.
The most preferred mode through which borrowers and lenders can easily seek each other out is through enrolment on a P2P lending platform. This form of lending/borrowing has witnessed significant growth in the past few years. For instance, in 2015 alone, there were 20 new online P2P lending companies established in India. Similarly, by 2016, 30 new lenders were known to be operating in India. The numbers have increased steadily year on year.
How P2P Lending Works?
All prospective lenders and borrowers need to sign up on a P2P lending platform. They also need to sign up as members to actively participate in the process. Before allowing participants to initiate the borrow or lend process, the P2P lender generally performs several checks related to employment, credit history, loan purpose, etc. While these checks may seem similar to any other that is performed by a banking institution, the P2P lending terms and conditions are often flexible.
Once the checks are conducted and depending upon the results, borrowers are tagged under various categories as per their perceived risk of default. For a borrower, the higher the potential risk, the more the interest rate charged on P2P loans that will be offered, Similarly, lower interest rates will be charged in case of borrowers that pose a lower risk of default.
Prospective borrowers have the option to either select a loan from the tagged risk category and pay the calculated rate of interest. He/she can also get prospective lenders to bid on a range of suitable interest rates. Similar to other crowd-funding initiatives, it is common to have multiple lenders pitch in their resources for providing a loan to one large borrower.
Lenders who wish to use the service must undergo certain checks to ensure that the funds they offer as loans are not being obtained through any illegal activities. After a lender has signed up for a P2P lending service, the available choices are – bid on listed loans or let the P2P platform distribute the lender’s funds among many borrowers who carry different risk profiles. This way, the lender’s risk is distributed and potential returns can be increased.
Are there any Advantages of Peer-to-Peer Lending?
Listed below are some of the advantages offered by peer-to-peer lending:
- P2P lending platforms provide easy loans to individuals who are unable to meet the conventional lending criteria that are prescribed by traditional lenders like banks.
- Lenders also benefit as they can earn higher rates of return from the loans they offer to P2P borrowers.
- P2P offers the perfect transaction platform for lenders and borrowers who want to negotiate rates themselves instead of letting middlemen decide the rates for them.
- The P2P lending process is often streamlined with significantly faster loan processing.
- P2P lenders don’t charge any pre-payment penalty, which helps increase the flexibility that these loans offer.
What is the Reserve Bank of India Guidelines for P2P Lending in India?
In India, P2P lending has gone unnoticed till very recently. However, the Reserve Bank of India recently published a paper on this nascent financial segment and the requirement for it to be regulated. It also noted that P2P lenders must be classified as new age Non-Banking Financial Companies (NBFCs). Such a big move from the central bank is expected to provide much-needed validity for the P2P lending segment.
- Many P2P platforms have requested the introduction of a Nodal Agency to help them easily track the number of funds circulating in the system at all times.
- As P2P platforms continue to attract more and more users, Indian NBFCs are starting to take a note of them and some have even initiated tie-ups with various P2P lenders. This is mainly to acquire new customers.
- NBFCs are set to benefit as a result of such tie-ups because they offer a reduced cost of credit verification. This is expected to improve the profits of such companies and help them expand their businesses into unchartered territories of the Indian market.
- For loan applicants, they can enjoy a higher choice of lenders, which in turn, could help in reducing loan costs.
- As the country’s central bank is starting to see P2P lending as an emerging lending segment, traditional banks are no longer fearful of these lending channels.
- In the near future, peer-to-peer lending is expected to undergo many changes which will help in streamlining the entire loan application process. Some of the recommended improvements are direct loan transfer from the lender to the borrower to prevent money laundering. Additionally, the launch of ECS-based debit systems is also expected to facilitate timely loan repayment.
Peer-to-peer lending platforms will soon stand along with banks and NBFCs to offer maximum benefits for lenders and borrowers. These will potentially increase competition among various lending groups and thereby allow maximum bargaining power to borrowers. With streamlined processes and online transactions, P2P is expected to transform the way money is being lent and borrowed in India.